Foundations of Business 3e PowerPoint Presentation

Foundations of Business 3e

Pride, Hughes, & Kapoor

Mastering Financial Management

Chapter

16

Explain the need for financial management

in business.

Summarize the process of planning for

financial management.

Identify the services provided by banks and financial institutions for their business customers.

Describe the advantages and disadvantages of different methods of short-term debt financing.Evaluate the advantages and disadvantages of equity financing.

Evaluate the advantages and disadvantages

of long-term debt financing.

Learning Objectives

All the activities concerned with obtaining money and using it effectivelyDetermining the best ways to raise money

Ensuring money is used in keeping with the organization’s goalThe need for financingWhen expenses are high or sales are low

Opportunities to expand

What Is Financial Management?

Types of Financing

Short-term financingMoney that will be used for one year or lessCash flow—the movement of money into and out

of an organization

Inventory—speculative production (the time lag between the actual production of goods and when the goods are sold)

Long-term financing

Money that will be used for longer than one yearOften involves large amounts of money

Comparison of Short- and Long-Term Financing

Cash Flow for a Manufacturing Business

Financial management during the

economic crisisMore difficult to use many traditional sources of short- and long-term financing

More difficult for companies to sell

commercial paper

Number of corporations selling stock for the first time to the general public decreased

The number of businesses filing for bankruptcy increasedFinancial Management During the Economic Crisis

Business Bankruptcies in the United States

Proper financial management at all times must ensure that:

Financing priorities are established in line with organizational goalsSpending is planned and controlledSufficient financing is available when it is neededCredit customers pay their bills on time and past-due or delinquent accounts are reduced

Bills are paid promptly to protect the firm’s credit rating and ability to borrow money

Funds are always available to pay taxes on time

Excess cash is invested in CDs, government securities, or conservative marketable securities

Financial Management During the Economic Crisis (cont.)

Financial Reform After the Economic Crisis

Financial reform after the economic crisis

Goals are:

Hold Wall Street firms accountable for their actions

End taxpayer bailouts

Tighten regulations for major financial firmsIncrease government oversightDebate about:Limiting executive pay and bonusesLimiting the size of the largest firmsCurbing previously used speculative investment techniquesThe risk-return ratioBased on the principle that a high-risk decision should generate higher financial returns for a business and more conservative decisions often generate lesser returns

Skills and traits of successful financial managersHonesty

Strong background in accounting or mathKnowledge of how to use a computer to analyze dataExpert in written and oral communicationsJobs

Bank officer

Consumer credit officer

Financial analyst

Financial plannerInsurance analystInvestment account executiveCareers in Finance

Financial planA plan for obtaining and using the money needed to implement an organization’s goals

Developing the financial planEstablish organizational goalsDetermine how much money is needed to accomplish each goal

Identify sources of funds and which to use

Planning—the Basis of Sound

Financial Management

The Three Steps of Financial Planning

Establishing organizational goalsGoal

An end result that an organization expects to achieve over a one- to ten-year periodMust be specific and measurableMust be realistic

Developing the Financial Plan

Developing the Financial Plan (cont.)

Budgeting for financial needs

Budget

A financial statement that projects income and/or expenditures over a specified future period

Usually begins with sales and various types of expenses

Cash budgetProjects cash receipts and expenditures over a specified periodTraditionalBased on dollar amounts in budget for preceding yearZero-based budgetingEvery expense in every budget must be justifiedCapital budgetEstimates a firm’s expenditures for major assets and its long-term financing needs

Developing the Financial Plan (cont.)

Identifying sources of fundsSales revenues

Provide the greatest part of the firm’s financing

Equity capital

Money received from the owners or from the sale of shares of ownership in the business; long-term financing

Debt capitalBorrowed money obtained through loansProceeds from the sale of assetsIf absolutely necessary or when no longer neededMonitoring and evaluating financial performancePrevents minor problems from becoming major ones

Cash Budget for Stars and Stripes Clothing

Traditional Banking Services for Business Clients

Checking accounts

Check

—a written order for a bank or other financial institution to pay a stated dollar amount to the business or person indicated on the check

NOW account

—an interest-bearing checking accountSavings accountsPassbook savings accountCertificate of deposit (CD)—a document stating that the bank will pay the depositor a guaranteed interest rate for money left on deposit for a specified period of timeShort- and long-term loansLine of credit—a loan that is approved before the money is actually neededRevolving credit agreement

—a guaranteed line of credit

Collateral—real estate or property pledged as security for a loan

Credit card and debit card transactions

Banks and other financial institutions charge merchants fees (a percentage of each credit card transaction) for handling the transactions for the merchantDebit card—a card that electronically subtracts the amount of a purchase from the cardholder’s bank account at the moment the purchase is made

Traditional Banking Services for

Business Clients

(cont.)

Electronic funds transfer (EFT) system

A means of performing financial transactions through a computer terminal or telephone hookupChanging how banks do businessAutomated teller machines (ATMs)

Automated clearinghouses (ACHs)

Point-of-sale (POS) terminals

Electronic check conversion (ECC)

Online Banking

Popular methods of paying for import and export transactions

Letter of creditA legal document issued by a bank or other financial institution guaranteeing to pay a seller a stated amount for a specified period of time

Banker’s acceptance

A written order for the bank to pay a third party a stated amount of money on a specific date

Currency exchange

International Banking

Sources of Unsecured Short-Term Financing

Unsecured financing

Financing not backed by collateral

Trade credit

Financing extended by a seller who does not require immediate payment after the delivery of the merchandise

Promissory notesA written pledge by a borrower to pay a certain sum of money to a creditor at a specified future dateUnlike trade credit, promissory notes usually include interestLegally bindingNegotiable instruments

Sources of Unsecured Short-Term Financing

(cont.)Unsecured bank loans

Interest rates vary with each borrower’s credit rating

Prime interest rate

The lowest rate charged by a bank for a short-term loan

Offered through promissory notes, a line of credit, or revolving credit agreementCommercial paperShort-term promissory note issued by a large corporationInterest rates are usually below that charged by banks for short-term loans

Average Prime Interest Rate Paid by U.S. Businesses

Sources of Secured Short-Term Financing

Loans secured by inventoryInventory is pledged as collateralControl of the inventory passes to the lender

until the loan is repaid

If the lender requires storage of inventory used

as collateral in a public warehouse, the borrower

pays storage feesLoans secured by receivablesAmounts owed to a firm by its customers are pledged as collateralQuality of receivables is considered

Sources of Secured Short-Term Financing (cont.)

Factoring accounts receivable

Factor

A firm that specializes in buying other firms’ accounts receivable

The factor buys accounts receivable for less than their face value

The factor collects the full dollar amounts when each account is dueThe factor’s profit is the difference between the face value and what it paid for the accounts receivableProfit is based on the risk (the probability that the accounts receivable will not be paid) the factor assumes

Comparison of Short-Term Financing Methods

Sources of Equity Financing

For sole proprietorships or partnershipsOwner or owners invest money in the businessVenture capital

For corporations

Sale of stock

Use of profits not distributed to owners

Venture capital

Sources of Equity Financing (cont.)

Selling stockInitial public offering

When a corporation sells common stock to the general public for the first time

Advantages of selling stock

Firm does not have to repay money received

from sale of stockFirm does not have to pay dividends to stockholders

Sources of Equity Financing (cont.)

Selling stock (cont.)Primary market

A market in which an investor purchases financial securities (via an investment bank) directly from the issuer of those securities

Secondary market

A market for existing financial securities that are traded between investors

Securities exchange marketOver-the-counter (OTC) market

Sources of Equity Financing (cont.)

Selling stock (cont.)Common stock

Stock whose owners may vote on corporate matters but whose claims on profits and assets are subordinate to the claims of others

Preferred stock

Stock whose owners usually do not have voting rights, but whose claims on dividends and assets are paid before those of common-stock owners

Par valueAn assigned (and often arbitrary) dollar value printed on a stock certificate

Sources of Equity Financing (cont.)

Retained earnings

The portion of a corporation’s profits not distributed

to stockholders

Venture capital

Money invested in small (and sometimes struggling) firms that have the potential to become very successful and extremely profitableInvestors usually receive an equity or ownership position in the business and share in its profitsPrivate placementStock and other corporate securities are sold directly to insurance companies, pension funds, or large institutional investors

Sources of Long-Term Debt Financing

Financial leverageThe use of borrowed funds to increase the return on owners’ equity

As long as the firm’s earnings are larger than the interest charged for the borrowed money, there is a positive effect on return on owners’ equity

Effects of Additional Capital

Sources of Long-Term Debt Financing (cont.)

Long-term loansTerm-loan agreement

For loans longer than one year.

A promissory note requires a borrower to repay a loan in monthly, quarterly, semiannual, or annual installments.

Interest rate and repayment terms are based on the reasons for borrowing, the firm’s credit rating, and the value of collateral.

The basics of getting a loanKnow potential lenders.Maintain a good credit rating.Fill out an application, submit a business plan and financial statements, and compile references.Meet with loan officer.If denied, determine why.

Sources of Long-Term Debt Financing (cont.)

Corporate bonds

A corporation’s written pledge that it will repay a

specified amount of money with interest

Maturity date—the date on which a corporation is

to repay borrowed moneyInterest is paid until maturityTypes of bondsRegistered bond—a bond registered in the owner’s name by the issuing companyDebenture bond—a bond backed only by the reputation of the issuing corporationMortgage bond—a bond secured by various assets of issuing firmConvertible bond—a bond that can be exchanged, at the owner’s option, for a specified number of shares of the corporation’s common stock

Sources of Long-Term Debt Financing (cont.)

Corporate bonds (cont.)Repayment provisions for corporate bonds

Bond indenture

—a legal document that details all the conditions relating to a bond issue

Call premium

—an amount paid to the bond owner if the corporation buys back the bond before the maturity dateSerial bonds—bonds of a single issue that mature on different datesSinking fund—a sum of money to which deposits are made each year for the purpose of redeeming a bond issueTrustee—an individual or an independent firm that acts as the bond owner’s representative

Comparison of Long-Term Financing Methods